Re-categorisation of stocks: Fund managers seek review of new norms

Want flexible methodology to define large- and mid-cap stocks

Equity fund managers, who manage assets worth Rs 6 trillion, are seeking a review of the re-categorisation norms introduced by the Securities and Exchange Board of India (Sebi) about two years ago. 

Money managers are of the view that some tweaking in the methodology prescribed for classifying a stock as large-, mid- or small-cap will bring about more flexibility in their investment calls and help curb unnecessary churn.

Under existing norms, the top 100 companies by market value fall in the large-cap bracket, the next 150 are tagged as mid-caps and the remaining stocks fall in the small-cap universe.

MFs have approached the market regulator saying instead of restricting the large-cap and mid-cap universe to a specific number of securities, it can be linked to a company’s contribution to the total market capitalisation.

“At some point in time, we need a re-look at how we define large, mid- and small-cap companies. Instead of fixing the number of companies, you can have a market cap-based benchmark. It would allow the market to expand to more and more companies as new firms get listed instead of a ranking system with an absolute number of companies,” said a top fund manager, adding that they have had a discussion with Sebi over this issue.

In October 2017, with the aim of ensuring true-to-label MF products, Sebi decided to lay down certain rules to define the universe of large-, mid- and small-cap stocks that MFs can invest in.

Based on stock price changes, industry body Association of Mutual Funds in India (Amfi) ranks stocks twice in a year – in July and January. Fund managers are then given a 30-day time period to realign their portfolios.

“The move is making it difficult to manage funds, especially in the mid-cap space. Due to the broader market correction, several mid-cap stocks have seen a price correction and are no longer part of the mid-cap category in the updated list. So, you have to sell such stocks even though they are fundamentally good; it also creates huge impact costs when markets are weak,” said a fund manager, requesting anonymity.

Industry insiders are also of the view that a universe of just 150 mid-cap stocks to choose from is restrictive. “At least 65 per cent of a mid-cap scheme’s exposure has to be in mid-cap stocks. The new norms limit the number of such stocks to 150, which is quite a small universe to choose from,” added another fund manager.

According to fund managers, a better alternative will be to just define a market cap-based threshold for the top-100 large-cap stocks and fund managers should have more discretion on any stock that is beyond this cut off. 

Alternatively, Sebi can tag companies that account for 80 per cent of the market cap as large-caps, says a fund manager. Market participants say the new norms have also given rise to arbitrage opportunities for other market players. 

“Traders have also started tracking what is likely to come in and go out of the funds and take tactical bets on the basis of this. It is not that difficult to gauge which stocks are likely to be bought or sold by MFs as Sebi has laid down a well-defined framework for this,” said another fund manager.

The MF industry had a challenging time last year implementing the re-categorisation norms, with the nature of several schemes and their underlying portfolios seeing a churn. 

Regulatory sources say they are open to market feedback. They would, however, be careful when it comes to tweaking the norms further as the exercise had proved painful last time around.